Inflation and Retirement

Inflation came to a 40-year high in June of 2022, when consumer prices were up 9.1% compared to the previous year. This peak represented the biggest 12-month increase since 1982. Monetary policy, when the Federal Reserve sets interest rates too low or when there is a rapid increase in the growth of money supply, is a key cause of an inflation increase. This, and increased government spending, the impact of the Russia/Ukraine war, increased household spending due to stimulus funds, and supply chain shortages resulting from the pandemic also have influenced the current high inflation rate. Fixed income households, including retirees, are challenged when inflation rates rise. While higher-income households and those still working can tap into savings and home equity when prices increase, this is not an option for many retirees. As such, revising your existing retirement investment strategy may be necessary in an inflationary environment.

There are several retirement strategies that can be considered to help you manage your finances so that your funds will keep up with your life expectancy. First, delay filing for Social Security until you reach full retirement age at 70 years. Payments are made in real dollars and benefits are adjusted annually, reflecting the Consumer Price Index. If cash flow is an issue in the early years of retirement, the gap between the actual age of retirement until Social Security benefits begin can be supplemented by drawing from qualified assets, like IRA’s and pension funds, or by purchasing a single-premium annuity, which can pay income during the bridge years.

Long-term care insurance can be purchased to make it easier to bear the costs associated with long-term care in retirement. This insurance provides peace of mind for those worried about living too long and those who are dependent on others for their care. Fortunately, Congress has made long-term care insurance tax-favored, and a number of states have passed legislation that allows certain long-term care insurance plans to be excluded when counting Medicaid eligibility requirements.

Investment strategy in retirement calls for juggling between the amount you can withdraw and the amount you need to invest for your balance to continue to grow. Investing a portion of retirement savings in equities, such as stocks and mutual funds, can help a retiree keep up with inflation and maintain a growth element in their portfolio. Preserving sufficient retirement capital addresses the risk of outliving your savings, and can help you leave an inheritance for family members.

When inflation is high, retirees should aim for a sustainable spending rate from their retirement portfolio. The common rule of thumb 4% rule entails adding up all investments and drawing down 4% of the total invested in the first year of retirement. Subsequent years are then adjusted to account for inflation, so there is a high probability of not outliving investments during a 30-year retirement. While the 4% rule is simple to understand, it may not be practical for all retirees. It can be used as a starting point, but it makes sense to look at individual spending habits so that adjustments can be made based on life expectancy, investments, and risk tolerance.